The dilemma of appropriation of payment: Drawing the line between the common law and the law of contract

November 1st, 2017

By Jason Olifant and Odwa Golela

A company is faced with quite a dilemma in a scenario where payment has been tendered by a debtor, but the debtor, however, has multiple debts with the company. When faced with this situation the company has to consider how it appropriates this payment to the various debts owed by the debtor and whether there are any rules or laws that apply in taking this decision.

This article, will take a closer look at how the law of contract dictates that payments made by a debtor be appropriated, particularly when the creditor (without prior consent from the debtor) appropriates the payment to a debt in relation to which the payment would have been appropriated to by operation of law.

A careful look at this situation is important in order to align what may possibly be a moot question in practice, with what may possibly undermine the element of consent in contractual relations in academics.

When a debtor has multiple debt obligations owed to a creditor, and makes a payment that does not cover the aggregate amount of the debt the rules of appropriation of payment are triggered.

The common law position relating to the appropriation of payments was set out in Miloc Financial Solutions (Pty) Ltd v Logistic Technologies (Pty) Ltd and Others 2008 (4) SA 325 (SCA) at para 46, where the Supreme Court of Appeal (SCA) held that where the parties did not appropriate the payment, the payment should be appropriated to the most burdensome debt and when the debts are equally burdensome, the payment should be allocated to the debt payment of which is in the debtor’s best interest.

When deciding on the appropriation of these debts we have to consider the difference between a debt, which is in the best interest of the debtor, versus one that is considered the most burdensome.

A debt that is in the best interest of the debtor would be the one that would facilitate in releasing the debtor from his or her indebtedness, while the most burdensome debt would be the one that would place the debtor further into debt such as a debt in relation to which interest has started building up.

Debts that are equal in all respects should be discharged in ‘chronological order’ (Van Huyssteen, Lubbe, Reinecke Contract General Principles 5ed (Cape Town: Juta 2016) at 495). When the debts do not fall within any of these rules they should be discharged ‘proportionally’ (Van Huyssteen et al (op cit) at 496).

The parties may also dictate how the payment should be appropriated under the rules of contract law, which are largely premised on the element of consent.

The debtor may also ‘indicate’ to the creditor the debt in relation to which the payment is made (Van Huyssteen et al (op cit) at 495). This indication must be made to the creditor before appropriation occurs under the rules of the common law (Van Huyssteen et al (op cit) and see also Christie and Bradfield Christie’s The Law of Contract in South Africa 6ed (Durban: LexisNexis 2011) at 444). Should the creditor agree to such appropriation, it may accept the payment and that particular debt will be discharged to the extent of the payment or wholly (Christie and Bradfield (op cit)). Should the creditor not accept such appropriation in circumstance where the creditor had a duty to co-operate with the debtor in ensuring that payment is made, the creditor may be in mora creditoris in relation to that debt (the requirements of mora creditoris should be met) (Christie and Bradfield (op cit) and for further details see LTA Construction Ltd v Minister of Public Works and Land Affairs 1994 (1) SA 153 (A)). The creditor may also reject the appropriation indicated by the debtor and regard it as positive malperformance (the requirements of positive malperformance must be met).

Traditionally a view was held that when a debtor did not indicate how its payment should be appropriated, the creditor could appropriate the payment when it received such payment or within an acceptable period after receipt of such payment (Van Huyssteen et al (op cit) at 495-496; Christie and Bradfield (op cit) at 444). However, an unreasonable appropriation was incapable of binding the debtor (Van der Merwe, Van Huyssteen, Reinecke, Lubbe Contract: General Principles 4ed (Cape Town: Juta 2012) at 445). It is for this reason that academics hold the view that the creditor has no ‘capacity’ to appropriate the debtor’s payment, it can only ‘propose’ a particular appropriation (Van Huyssteen et al (op cit) at 495). The latter seems to be the more desirable view as it clears the uncertainty brought about by subjecting the creditor’s appropriation to a test of reasonableness, as this may differ from case-to-case leading to palm-tree justice. Further, the latter view is premised on the principle of consent, should the parties not reach consensus then the payment is appropriated in terms of the rules of common law.

In setting out the law relating to appropriation of payments above, it is apparent that a situation may arise where the parties did not provide for appropriation of payment in their contract and the proper appropriation would then be determined by the rules of common law. However, the creditor may have appropriated the payment (on receipt) to the debt in relation to which the common law rules would have appropriated the payment to anyway. In this situation, the creditor has in theory appropriated the payment without leaving room for the debtor to refuse such appropriation (which we have already explained is undesirable, as such appropriation is later subjected to the reasonableness test). While practically, it can be said that the appropriation has occurred under the rules of common law, appropriation of payment in this case would also have occurred by operation of law. This situation renders itself open to abuse, as either the creditor or the debtor may choose to rely on the rules of contract law or common law (depending on which one best give either of them the result they desire).

To adequately address this situation, it is advisable that the creditor should not have the capacity to appropriate payment unless the parties have agreed to this in terms of a contract, which provides the creditor with the right to appropriate payment as it deems fit. Alternatively, payment should be appropriated in terms of common law rules (except where the debtor indicates how the payment should be appropriated and the creditor accepts such appropriation). The parties may then rely on remedies available to them under common law or as provided for in their contract.

In dealing with appropriation of payments it is desirable to distinguish between the rules of appropriation within contract law (when appropriation was provided for in the contract) and appropriation within the broader common law (when it was not provided for in the contract). The former is largely based on consent between the parties and appropriation is made in line with their intention, whereas the latter is not based on consent, but occurs by operation of law. As such it is more debtor-oriented (as the debtor is considered the weaker party between the two). It is, therefore, important to draw the distinction between the two sets of rules when dealing with appropriation of payment and to ensure that both parties are confined to one set of rules to reduce the risk of remedy shopping.

Jason Olifant LLB HDip (Tax) LLM (Labour Law) LLM (Commercial Law) (UJ) is a senior legal counsel and Odwa Golela LLB (UFH) LLM (Commercial and Business Law) (Wits) is a legal graduate at MultiChoice in Johannesburg.

This article was first published in De Rebus in 2017 (Nov) DR 16.